Seyfarth Synopsis: Contributing employers to multiemployer pension plans have seen some big developments in July. The PBGC released its new Final Rule on Special Financial Assistance on July 8, 2022, which will help financially troubled plans avoid insolvency, but will now also subject contributing employers to higher withdrawal liability assessments compared to the Interim Final Rule. On the same day that the Final Rule was issued, the D.C. Circuit rejected a plan’s use of a risk-free discount rate for calculating withdrawal liability, placing into dispute withdrawal liability discount rates used by many plan actuaries that differ considerably from their funding rate assumptions. Finally, the pending PBGC regulations on prescribed discount rate assumptions are coming soon. Employer beware.

For employers who participate in multiemployer pension plans, July has been a busy month. The PBGC published its Final Rule (FR) on the Special Financial Assistance (SFA) Program for financially troubled plans that was established as part of the American Rescue Plan Act of 2021 (ARPA), and the D.C. Circuit Court of Appeals issued its long awaited decision in United Mine Workers of America, 1974 Pension Plan v. Energy West Mining Company, Case No. 20-7054 (D.C. Cir., decided July 8, 2022). Employers, when monitoring their multiemployer plan participation, should review these developments and the pending PBGC withdrawal liability assumption regulations.

PBGC Final Rule

Earlier this month we published a summary of the key changes under the Final Rule from the Interim Final Rule (IFR) (click here). While we encourage you to read it, three changes in the Final Rule should be of considerable important to participating employers.

First, the PBGC revised the interest rate assumptions plans must use for purposes of calculating the total SFA amounts to be received. Under the IFR, plans were required to use the same interest rate assumption for both SFA and non-SFA assets, even though SFA assets were also required to be segregated and invested much more conservatively than non-SFA assets. By using the same investment assumptions for both, this meant that the amount of SFA provided likely would not be sufficient to pay all benefits due through the plan year ending 2051, given plans would have to invest the SFA in investments with lower returns. To address this, under the FR there is a separate interest rate assumption for non-SFA plan assets, and a more conservative interest rate assumption for SFA assets. This should increase the total amount of SFA plans receive, making it more likely that plans will have sufficient assets to avoid insolvency through 2051.

Second, the FR gives plans greater flexibility to invest SFA assets more aggressively. Under the IFR, 100% of SFA assets were required to be invested in investment grade fixed income securities. The Final Rule, however, allows plans to invest up to 33% of SFA assets in return seeking investments (e.g., publicly traded common stock, equity funds that invest primarily in public shares, bonds, etc.), with the remaining 67% restricted to investment grade fixed income securities. This development provides plans with an important element of flexibility in the investment of SFA assets, and it could significantly increase the likelihood that plans will be able to avoid insolvency through 2051.

Third, the FR switched course on how SFA funds must be recognized for purposes of determining total unfunded vested benefits and, hence, withdrawal liability. The IFR previously required all SFA funds to be counted immediately when calculating unfunded vested benefits. As a result, the infusion of SFA assets into a financially troubled plan would generally reduce its overall underfunding percentage and, hence, reduce withdrawal liability assessed on withdrawing employers. To balance that, however, and to discourage participating employers from subsidizing their withdrawals with SFA funds, any plans receiving SFA funds are required to calculate and assess withdrawal liability using PBGC plan termination rates as the applicable discount rate — in other words, plans must use basically a risk-free discount rate. Mandatory use of this artificially low discount rate was designed to inflate the underfunded status of a plan, in order to increase the amounts of withdrawal liability assessed, and thus prevent withdrawing employers from directly benefiting from the SFA. Whether a withdrawing employer would benefit or be harmed from that “asset increase/discount rate reduction” tradeoff would depend upon the specific plan, its financial status, and the discount rates it traditionally uses for withdrawal liability.

In a departure from the IFR, the FR institutes a “phase-in” feature for crediting SFA funds for purposes of determining unfunded vested benefits, and in turn, withdrawal liability. The phase-in period begins the first plan year in which the plan receives SFA and extends through the end of the plan year in which the plan expects SFA to be exhausted. How long the phase-in period can last will depend upon when the plan anticipates to have spent all of the SFA it receives. To determine the amount of SFA assets excluded each year, the plan multiplies the total amount of SFA by a fraction, the numerator of which is the number of years remaining in the phase-in period, and the denominator is the total number or years in the phase-in period. The phased recognition of SFA assets does not apply to plans that received SFA funds under the terms of the IFR unless a supplemental application is filed.

While individual employer experiences may vary depending upon the plan, phase-in period, and when they withdraw, among other things, what this means is an employer withdrawing from a plan that receives SFA will automatically be assessed withdrawal liability using PBGC plan termination rates (which as of the date of this publication are currently running at 2.81% for the first 20 years and 2.94% thereafter), when many plans use 6.5% to 7.5% funding rate of return assumptions for that purpose. Yet, that same employer may only see very little of the SFA assets credited toward the plan assets for calculating withdrawal liability under the FR.

Instead of preventing withdrawing employers from receiving a windfall, the FR phase-in will end up subjecting many employers that withdraw during the phase-in period to higher withdrawal liability assessments (than had plans received no SFA). As seen from Energy West below, the difference in discount rates (absent any offsetting SFA) can lead to significant increases in withdrawal liability. Depending upon the plan, this phase-in “penalty” could last for a few or many years. Participating employers need to understand this risk, the phase-in period, and the potential costs of remaining in a plan that intends to seek SFA.

Energy West Mining Company

On July 8, 2022, the same day the PBGC issued its FR, the D.C. Circuit Court issued its long-awaited decision in Energy West. At issue in Energy West was whether a plan could use the PBGC plan termination rate as the discount rate for purposes of determining an employer’s withdrawal liability. When Energy West withdrew in 2015, the United Mine Workers Plan actuary applied the risk-free PBGC plan termination rate — 2.71% for the first 20 years and then 2.78% thereafter — as the discount rate to calculate withdrawal liability. That resulted in an assessment of over $115 million. Had the actuary used the 7.5% discount rate assumption he had set for plan funding purposes based on the plan’s historic investment performance, the assessment would only have been about $40 million. The actuary chose the PBGC rates as his best estimate for withdrawal liability purposes because an employer withdrawing from a plan no longer bears any risk if the plan investments do not perform as anticipated.

While an arbitrator and district court ruled for the plan, the Circuit Court reversed. The Court found that the Multiemployer Pension Plan Amendments Act provision that the actuary use assumptions “which, in combination, offer the actuary’s best estimate of anticipated experience under the plan,” required that the actuary not only choose the discount rate, but that that rate be based on the plan’s actual investments. As the actuary’s assumption in this instance was not chosen on the plan’s past or projected investment returns, by definition it was not the actuary’s best estimate.

The Court reversed the decision, but did not mandate that the plan use the actuary’s 7.5% funding rate of return assumption. The Court recognized that the funding rate of return and the withdrawal liability discount rate assumptions need not be identical. There is some acceptable range of reasonableness based on a plan’s characteristics: “The assumed discount rates must be similar, even if not always the same.” The Court directed the district court to vacate the arbitration award and have the actuary recalculate withdrawal liability using a discount rate assumption based on the plan’s actual characteristics.

Energy West is now the second appellate court in the past year (the Sixth Circuit issued a similar ruling last year) to reject withdrawal liability discount rates that are not based solely on plan characteristics (i.e., on the actuary’s best estimate of anticipated experience under the plan). While not every employer will see a possible $75M reduction in withdrawal liability, many employers in plans that have differing funding and withdrawal liability rates, in theory, will see their estimated and actual withdrawal liability drop to the extent plan actuaries adopt withdrawal liability discount rates similar to plan funding interest rate assumptions.

How will actuaries respond to Energy West? It is highly possible that other appellate courts will disagree with Energy West, leading to a circuit split that may have to be decided by the Supreme Court. Hundreds of millions of dollars, if not billions, are at stake. Moreover, it remains to be seen how “similar” discount rates need to be to the funding rates of return.

But Wait, There’s More

Last and certainly not least, the PBGC is still drafting regulations that will prescribe actuarial assumptions which may be used by a plan actuary in determining withdrawal liability. It is anticipated the PBGC will bless some methods — perhaps even the use of the risk-free PBGC plan termination rates — that will permit the application of considerably lower discount rates than what would otherwise be assumed based solely on plan experience. Such regulations, which are imminent, may moot this issue — at least for employers that have not withdrawn before the regulations become final.

Given the FR, Energy West and similar cases, and of course the pending PBGC regulations on actuarial assumptions, participating employers need to keep their eyes open on the latest developments to avoid possible surprises.